Saving the Euro – Flood it or Leave it!

11^th November 2011

The Malta Independent

Not many choices are left to save the euro. It has brought down the Prime Ministers of all troubled countries, in Ireland, Portugal and probably Spain through fresh elections and in Greece and Italy (work-in-progress) through bond market pressure for the formation of a wide-based national government that can be trusted to take the tough measures needed for proper economic restructuring without the interference of re-election prospects coming into the equation

Yet the fate of the euro is hanging on a thread. It takes one missed debt auction by a government like Italy or France to set the euro house on fire. It takes depositors loss of confidence in Italian banks, just as the Greeks have lost confidence in their own banks, to damage the system beyond repair.

That we have a grave problem on our hands is best exhibited by the likely booting out of Berlusconi from the Prime Ministerial seat in Italy. The bond market will succeed where sex scandals, financials impropriety, tax evasion and unbecoming behaviour failed. But when yields on 10-year Italian government bonds exceeded 6.77% and the margin between Italian bonds and German bonds widened to more than 5% that was it! Even his closest allies could not avoid reading the writing on the wall that no one, not even a political survivor like Berlusconi, can challenge the bond market.

The grave problems plaguing the euro system have to be sorted out in one of three ways. And none of these three possible solutions needs to come from any meeting of the 17 EU member states or Ecofin meetings of the respective finance ministers. Such meetings have become an utter waste of time producing complicated and half-backed decisions concocted by the Merkozy tandem to address last year’s problems. EU governments remain hopelessly behind the curve and have lost all market confidence they have or can get things under control.

The most obvious solution is for the ECB to take the lead and do what central banks are meant to do when facing a financial crisis of this magnitude. I have been repeating this ad nauseum in my recent writings. In a monetary union that is not under-pinned by a common fiscal policy and a common treasury, monetary policy has to be much more forceful and flexible. Forceful in setting and implementing discipline during the good times, by taking the punchbowl away before the party gets too hot; by using its moral suasion powers over governments of countries that find the common euro interest rate unsuitable for their particular requirements, to take supplementary local measures, both fiscal and direct, which make up for the inadequacy of the common interest rate policy. Flexible during times of crisis to take measures that procure financial stability that only a Central Bank operating autonomously, without need to get the complicated approval of 17 national parliaments can do.

The ECB is doing nothing of the sort. Probably it feels that this goes beyond its mandate but in such case it should seek a change of its mandate rather than preside over the euro disintegration. After all it is the ECB President’s signature that goes on the euro notes and not the signature of Merkel or Sarkozy.

When the going was good, the ECB was blind to the asset price inflation happening in Ireland and Spain as real estate prices soared, fuelled by inappropriately low interest for their domestic conditions. These low interest rates were tailored to suit Germany’s economic fatigue of integrating the East with the West. The ECB could and should have used its moral suasion authority to calm down such asset price inflation in Ireland and Spain through direct controls over private credit growth. Asset price increases move hand in hand with private credit growth and control of credit growth would have avoided the speculative boom that blew up the Irish and Spanish economies.

Now that we are in crisis the ECB is not being bold enough to put out the fire ignited by the politicians’ mishandling of the situation. The ECB is reluctantly supporting sovereign bond markets of Italy and Spain when it should be really making it clear that it has no limits how much bonds it would buy to keep yield spreads sustainable provided governments of countries in distress do what needs to be done to render their fiscal position sustainable in the long term.

The ECB is the only institution that can match the power of bond markets. It has unlimited resources as it can monetise its bond purchases and can provide whatever funding is needed by the EFSF without raising taxes anywhere, without forcing countries to take on undue leverage risks and without humiliating Europe having to go cap in hand to seek financial support from China and the like.

To be fair the change of leadership at the ECB effective 1 November, 2011 bodes well. Since Draghi has assumed the role of President there are all his fingerprints over the manoeuvre to force Berlusconi out of his position. When the ECB slowed supporting Italian spreads by slowing its bond purchases, Berlusconi had to come to terms with the force of the Bond market that had lost all confidence in his ability to re-invigorate the Italian economy.

Some might validly argue that it is undemocratic for the ECB to have such powers over sovereign elected governments. Democracy is never perfect and checks and balances are needed when democratically elected politicians start putting their personal and narrow self-preservation interest before the interest of the country and the people they were elected to serve. Pressure by other countries could be perceived as imperialism and foreign interference. Consequently, subtle action by a technocrat board of 22 central bankers from all euro area countries is the least democratically offensive solution for the greater good of the nation and the Union.

Failure by the ECB to do what needs to be done will mean the break-up of the euro in the not too distant future. And this comes in two choices. Either the weak links have to leave permanently, or the strong links have to exit at least temporarily.

The biggest disaster for the soul of Europe is if the weak are forced to leave. If Greece is forced to leave the euro, the rapacious oligarchs that through their corruption have broken the Greek economy, will have the biggest laugh at the expense of the decent Greeks who earn relatively little, but unlike the corrupt super rich, actually pay their taxes. These oligarchs control large parts of the Greek business, the financial sector, the media and indeed politicians. These oligarchs have been exporting cash from undeclared profits out of the Greek economy so much so that the London property market is reported to have received a boost from Greek buyers. If Greece is forced out of the EU and revert to the Drachma which will have to be grossly devalued, these oligarchs would make huge gains from their foreign assets and will be able to buy on the cheap public assets priced in devalued drachma that will have to be privatised under duress to enable the Greek government to find the funds that will no longer be available from bailout EU sources.

On the contrary if the strong countries exit the euro the domestic currencies they will temporarily revert to will strengthen and will make imports from Greece and other countries that stay in the euro cheaper and more attractive. It will also stimulate direct investment flows from north to south so that the Greek restructuring is based on a dimension of growth not solely on austerity. In the process Greece will be helped to sharpen its institutional arrangements to bring the tax evasion and corruption under control and offenders to the book.

Germany has a choice! Let the ECB act as a true Central Bank, or bring misery and total disorder to the southern flank of Europe, or temporarily exit the euro to permit an orderly recovery of competitiveness across the whole euro area and eventual re-merge into a single euro under new rules and at realistic conversion rates reflecting current realities. Search for other solutions is a waste of precious time and resources.

Alfred Mifsud

What a Fudge

6^th October 2011

The Malta Independent on Sunday

The supposedly comprehensive solution negotiated at the EU / EURO summit on 26 October is a hopeless, useless, dangerous and patched-up fudge which offers no solution to the problem of the euro debt sovereign crisis. On the contrary, it puts the whole system more and more at risk.

This is no comprehensive agreement at all. Before you know it, we will have the EU leaders convening again for urgent crisis discussions, trying to put together the fourth, fifth or nth version of the supposedly definitive agreement. The EU political leaders are as usual behind the curve and hopelessly falling further behind. The supposedly EU leadership tandem of Chancellor Merkel and President Sarkozy have no idea, I repeat no idea, of what the problem is and consequently cannot even come close to defining a real solution which could convince the markets that they have things under control.

If Berlusconi is a buffoon, at least he lives up to his reputation and never pretends that he can lead the EU out of this crisis. If anything, Berlusconi has shown he is a political fox excelling in the art of survival. He uses the business acumen that turned him from a cruise-ship singer into a multi-billionaire businessman that sought refuge in politics to protect his private wealth, and outfoxed politicians with better credentials to have three Italians on the Board of the ECB while the Germans only have two and the French have only one − just like tiny Malta! This is no small matter as the ECB is the only institution standing between survival and the total economic disaster being cooked up by EU politicians.

This is no small matter for Malta. We have committed ourselves to financial obligations exceeding seven hundred million euro as part of our contribution to the European Financial Stability Fund (EFSF). These are no peanuts. This is more than 11 per cent of our GDP and 16 per cent of our existent national debt. It is equivalent to a commitment of €1,750 for every resident. If it were to offer a realistic hope of a solution to the euro sovereign debt crisis then one could say that the benefits of inherent stability essential for economic growth will make the sacrifice worthwhile and will make the actual drawdown on our commitment less likely. But it is nothing of the sort.

It has become insulting the way Germany is treating peer countries like us who are trying to save the euro, let alone the way they are treating debtor countries that need to be saved. Many examples show it is time for us to stand up and protest that this is not the EU we decided to join and that it is time for the EU to move back to the collegiality of its leaders and the Commission, and not to the bilateral Merkozy meetings.

Germany expected all euro member Parliaments to rubber stamp the definitive agreement reached on 21 July and showed impatience with Slovakia, which was rightfully dithering about approving the agreement to the point of bringing down a government coalition recently elected.

Germany insisted that all euro countries contribute proportionately, irrespective of whether they are founder members (and therefore have enjoyed benefits from the excesses of countries in distress) or recent entrants (who have not so benefited).

Germany is objecting to sensible proposals for the ECB to fund through defensive monetisation the bazooka needed to shock and awe the market with its preparedness to insulate illiquid economies like Italy, Spain, Portugal and Ireland from the solvency problems of Greece. Instead, Germany has forced peer governments to agree that their commitments to the EFSF could be dangerously leveraged up four times magnifying risks hundredfold. Germany has chosen the irresponsible leverage model that brought the world to its knees in the financial crisis of 2008 to avoid defensive monetisation, which in the current environment causes no risk of inflation the Germans still fear like the plague. Through their obstinacy and rigidity the Germans have chosen the larger, much larger of the evils on the menu.

Germany is obliging the EFSF to humiliatingly go cap in hand to the IMF and China begging for financial support when Europe is rich enough to self-help.

In a diabolic effort to avoid an unavoidable Greek default but still cut down Greek debt through ‘voluntary arrangements’, Germany has created a moral hazard that other countries cannot disregard without invalidating their democratic legitimacy. What arguments can governments of countries like Italy, Spain, Portugal and Ireland make to their electorates for choosing austerity rather than the Greek route of debt forgiveness?

There was a much more sensible and effective approach to find an effective solution to the sovereign debt problem. The solution does not involve any country putting in any money to help another, which goes against the very Treaty of Maastricht setting the euro rules. The solution was for the ECB to monetise a shock and awe fund to recapitalise EU banks that would be hit by allowing Greece to go bankrupt and negotiate down its debt as is quite normal to do in bankruptcy.

Bank recapitalisation would have happened instantly not on if-you-need-it basis. Banks would have had to take on fresh capital to protect their stability in these uncertain times where extra capital is much preferable to just enough. Banks should not be allowed time to shrink themselves down to the available capital as this works against economic growth so necessary for a truly lasting solution to the crisis.

The pity in all this is that the Germans are putting our money at risk by devising hopeless, defective and totally out-of-touch-with-the-market solutions. Our government and opposition should wake up and stop rubber-stamping whatever the Germans send us through the EU structures. It is our money, it is our future, and it is our survival that is at stake.

The Germans, after the summit of 23 October, called another meeting for 26 October as they wanted to run the deal through their Parliament for specific approval. The Germans are not the only democracy with a Parliament, as Luxembourg Prime Minister Junker so eloquently put it. The Greeks have now responded that they want the deal to be approved by the electorate in a referendum.

How about our politicians treating us with respect and subject further involvement that exposes us financially to specific parliamentary approval or indeed to a referendum? We have nothing less than the Germans and certainly nothing less than the Greeks.

Only if people from other EU countries like us, who like the Germans are putting their neck on line to save the euro, get involved in such decision-making, will the Germans finally shed their arrogance and intransigence and let the ECB do what Central Banks are supposed to do when facing a financial crisis. And if this would need a change to the ECB or German Constitution so be it; much better than putting our hard-earned money on the roulette table.

Alfred Mifsud

Occupy What?

23^rd October 2011

The Malta Independent on Sunday

It had to happen! The untold misery brought about by the recession caused by the financial turmoil that started in 2007/2008 and is still rambling on, inevitably motivated the anti-globalisation crowd, often rowdy, violent and detestable, to morph into a much more convincing and civilised ‘Occupy Wall Street’ movement. This has been exported internationally, with the ‘Wall Street’ bit in the title being adopted by different nations to parallel home symbols of financial excess.

While the ‘Wall Street’ brand is a powerful representation of capital markets which people can easily connect with, it is rather a misplaced target. It is the financial markets rather than the capital markets that have brought the world’s economy to its knees, and the financial markets are not traded on Wall Street but are mostly traded on the invisible inter-bank electronic markets.

What the protestors are probably promoting is not the physical occupation of New York’s Wall Street, London’s City, or Malta’s Castille, but really their banner is notionally ‘Occupy us’; give us a job; restore our human dignity; don’t let us pay for the excesses of greedy bankers who are still enjoying their multi-million dollar bonuses from transactions that eventually brought about the crisis; spread the adjustment pain more equitably; don’t let the banks, in spite of the damage they caused, to remain masters of the universe abusing their too big to fail status.

That something is wrong with the world financial order is best glimpsed from two odd facts.

Is it not strange that we are caught in a situation where the poor of the world are financing the excesses of the rich? China, India, Russia, Brazil, Indonesia and the like, with balance of payments surpluses, are the major holders of US Treasury securities, mortgage bonds and such like US securities. Logic would indicate that Third World countries where poverty is still prevalent and where the average per capita GDP is a mere fraction of the average US per capita GDP, would better employ their surpluses to develop their own economies rather than buy US debt.

However, logic does not always prevail. There is a limit to how fast emerging economies can develop without igniting damaging inflation. Economies have a limited absorption capacity for new investments particularly as one has to bear in mind that such investment is generally concentrated in major cities, forcing fragile population shifts from rural areas to urban city centres. There is a limit to how fast cities can grow to accommodate such shifts without creating social problems which would challenge the stability of the political structures.

Take China. Having millions over millions of rural undernourished peasants spread in the wilderness of greater China does not offer much challenge to the stability of China’s central command. However, having a few concentrated millions forced to live in inhuman conditions in city centres with dashed expectations of a much better life, can be a formidable challenge to the political stability of the regime. China thus can ill afford to have annual growth rates below eight per cent p.a, but will be hard put to push growth rates above 10 per cent p.a. without stoking property bubbles and inflation fires.

China is unable to allow its surpluses to seep into much higher consumption rates by its population because, inflation apart, this will of itself widen the income gap between the top echelons of society and the rest. This cannot sit too comfortably with stability for a communist regime. China is thus forced to park its surplus in US Treasuries and has become the US biggest creditor, to the extent that China loudly complains when the US, benignly or otherwise, neglects to protect the exchange value of its dollar.

The other odd symptom of the troubles plaguing the financial system is the remuneration realities in the financial sector and the rest of the economy. When a structural engineer designing bridges that add wealth and efficiency to the economy is paid less than 10 per cent of the remuneration package of a yuppie financial engineer who puts together financial products with strange names like MBS, CDO or CDS that few understand and which add little value to anyone but the bank designing them and selling them, then something must be wrong somewhere. So wrong that we have seen traditional economic powerhouses, like the US and UK with traditionally strong manufacturing bases, lose their productive strength through migration of their industries to cheaper locations resulting in dangerous concentration of their economies on the financial sector. In the end, the modern day poorly regulated financial sector produces nothing but short-term profits at the expense of long-term damage when the bubble bursts.

There is never an easy solution to problems that have accumulated over several years and when strong petrified imbalances have to be addressed through painful reversal of well-ingrained policies with many vested interests defending the status quo. And no one has yet come up with a feasible true solution to the current crisis.

We have been fire-fighting the crisis and in the process shifting the problem from one sector to the other rather than addressing issues at their true sources. We have seen governments coming to the rescue of financial institutions, exposing taxpayers money to risks without commensurate return; governments sinking to their ears in debt and having no room left to stimulate economies in distress in terms of classic Keynesian teachings. Government debt has in many instances reached unsustainable proportions raising doubt on their ability to service and repay their debts. This has shifted the problem back to the banks that hold on their balance sheets plenty of such sovereign debt, traditionally considered gilt-edged but now increasingly doubtful.

Where do we go from here, is the obvious question. World leaders seem unable to embrace the problem. The US is in political paralysis with the President and Congress unable to agree on a sensible economic policy. With elections due in 12 months’ time no party is in the mood to compromise and the election result is perceived as the ultimate resolution. In the EU there are too many leaders but no one is in overall charge. Emerging economies have a problem switching their economic model from export-led to one based on internal development and increased consumption. Supranational organisations like the IMF and the World Bank do not seem to have either the resources or the moral authority to knock heads around to orchestrate an international consensus for a co-ordinated approach towards a real solution. G-20s, G-8s or G-n’s over-promise but consistently under-deliver.

In the absence of some political strong and co-ordinated political leadership that can frame the problem in a language that people can understand, make proper exposition of the consequences if problems continue to be neglected, and orchestrate a co-ordinated solution that spreads the pain equitably among surplus and deficit countries, the only solution left would be a choice between a deep depression or a prolonged recession accompanied by inflation, which, over a number of years can work its way to making debt burdens more sustainable. In any event, the greatest burden will fall on the weakest.

Occupy Wall Street and similar movements are important to raise sensitivity about important issues but they never offer true solutions. Like similar popular movements, Occupy Wall Street and their like have a clear idea of what they do not want, but rarely have any clear ideas about what they actually want or how to achieve it

Alfred Mifsud